Partner Buyout Financing: How to Buy Out a Business Partner
If you want to buy out a business partner, you must purchase their ownership interest at fair market value. This process requires implementing an effective strategy that includes communicating honestly and acquiring enough funds to complete the transaction. Buyout reasons can include a desire for full control, differing views on the business’s direction, retirement or even death.
Understanding Buyouts
A buyout refers to a transaction where one party acquires another party’s ownership share in a business. Depending on who the buying party is, ownership changes are classified into various types, such as:
- Partner buyout.
- Management team buyout.
- Employee buyout of a small business.
- Private investor acquisition.
- Company acquisition.
What to Do Before Buying Out a Business Partner
Because a partner buyout will change the company’s ownership structure and its future direction, it’s critical to perform the tasks below to ensure a smooth transition.
- Consider the company’s future: Evaluate the buyout’s impact on business operations and how you plan to address it. If your partner is hands-on, determine if you’re ready to take on their responsibilities or hire someone to handle these tasks. Examining a future without your business partner will help you prepare for the possible effects.
- Think about partner buyout financing: Buying out a business partner is often a significant expense that requires careful planning. If you can’t pay the full amount out of pocket, consider the funding options you can explore.
How to Buy Out a Business Partner
When buying out a partner in a limited company or other type of business partnership, the process will begin with preparation. Review the business’s buy-sell agreement to confirm the formula for setting a buy-out price, the payment terms and other protocols that will guide the process.
Next, undertake the steps below.
1. Kick-Start a Positive Conversation
Open a conversation with your business partner in a positive tone to determine a buyout plan that works for both of you. Clearly communicate and document the expectations and goals of each party to simplify the legal process. Regardless of the reason for the buyout, maintain a friendly, easy-going tone during the discussion.
2. Seek Legal Counsel
Both parties should get independent lawyers to guide the transaction. Your attorney will help you with the negotiations and advise you on your obligations as the buyer.
3. Determine the Business’s Value
You and your partner should schedule an independent valuation to provide a starting point for negotiations. The valuation should determine the company’s accurate, fair market value.
4. Negotiate a Price
Based on the business value, discuss the offer price with your attorney and then present it to your business partner with justifications. Be open to compromise within reasonable limits, regardless of their initial response.
If the buyout reason is retirement, negotiate a lower buyout price by agreeing to take responsibility for their retirement benefits.
5. Create the Buy-Out Agreement
Once you and your partner agree on a price, your lawyer will draft an agreement detailing all relevant terms, including the buy-out deadline, a non-compete clause, and how you’ll finance the purchase. Agreements must meet state buyout laws.
Business partners can agree to proceed with one of these buyout structures:
- Installment
- Lump sum
- Seller financing
- Lender financing
6. Finance the Buyout
After signing the agreement, send payment within the agreed-upon timeline. If you need to secure financing for the purchase, submit a loan application early to an institution with favorable interest rates to enable timely payment.
It’s essential to consult with a professional tax advisor to understand the tax implications of the buyout. Your tax obligation depends on the presence of a goodwill payment and whether the Internal Revenue Service (IRS) considers the buyout a capital gain/loss, ordinary income or if the payment is deductible by the remaining partner.
7. Ownership Transfer
Your business partner’s lawyer will file the necessary legal documents with the authorities to complete the ownership transfer.
8. Inform the Relevant Parties
Send official notifications about the change in ownership to employees, customers and other stakeholders.
9. Update Business Documents
Update the partnership agreement, bank accounts, insurance policies and other records to reflect the changes in business ownership.
10. Implement Post-Buyout Tasks
Collaborate with the departing business partner to hand over responsibilities to you or an employee.
11. Focus on the Future
Now that the business has a new ownership structure, you can implement strategies to guide it into the future.
How to Finance a Partner Buyout
Financing is a vital aspect of a buyout as it determines how you’ll purchase your partner’s share in the business. With so many options available, it’s advisable to consult with a reputable financial advisor to help you choose low-risk options.
Examples of funding options include:
Personal Financing
If you have a considerable amount of saved funds, you can use them to complete the entire transaction. Other options include selling your assets or borrowing funds from friends and family.
Business Profits
If your business can spare its retained earnings, you could use them to complete the buyout. Talk to your tax advisor to determine if this option is tax-efficient.
Equity Financing
This option involves selling stocks to individuals, venture capitalists or angel investors to raise capital. Alternatively, you can sell stocks publicly through an initial public offering (IPO).
Debt Financing
Debt financing involves selling debt instruments like bonds and bills to institutions or individuals in exchange for funds. You can also borrow money through small business, non-bank cash flow and recurring revenue loans.
Merchant Cash Advance
This arrangement is a lump sum payment that you’ll repay, plus a fixed fee, using a percentage of the business’s revenue. Consider this option if your business generates consumer sales.
Seller Financing
Your business partner can lend you the funds to buy them out in exchange for installment payments. This is a win-win financing option since it saves you from the financial implications of a lump sum payment and gives your partner a steady income source.
Mezzanine Financing
This option combines equity and debt financing and adapts repayment to the business’s cash flow. The lender can convert the loan to equity interest if you’re experiencing repayment challenges.
Deferred Compensation
The selling and buying partners can agree to a buyout that spreads out payments over a defined period. This option is ideal if you don’t have the funds to pay in a lump sum.
Insurance Policies
If the buyout is a result of your partner’s death, you can purchase their share with life insurance as long as you had one set up beforehand. A disability insurance policy can also provide financing if your business partner can no longer work.
Contact Marshall Jones for Help Buying Out a Business Partner
Marshall Jones Certified Public Accountants And Advisors is here to offer financial and tax advice to simplify your buyout. We have over 30 years of experience in the industry and a reputation for meeting client needs. We’ll tailor our solutions to your unique situation to streamline the process.
Reach out to us online and let us help you save time, re-focus your resources and improve your operations.
